The government is not seeing eye-to-eye with the central bank of Thailand when it comes to monetary policy in the country.

The government, particularly the finance ministry, has expressed that it wants monetary policy to complement its fiscal policy efforts to help increase the country’s economic output.

Compared to some of its regional peers, Thailand has not been growing particularly quickly. In Q2 2017, its economic output rose by 3.7% from a year ago, up from 3.3% in the previous quarter. Meanwhile, Indonesia’s economic growth stood at 5.01% and Malaysia grew by 5.8% in the same period.

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Providing credence to the government’s appeal is the low level of inflation in Thailand. Consumer prices rose by 0.86% year-over-year in September, below the floor of the 1-4% target range of the Bank of Thailand. This shows the central bank has headroom to reduce its benchmark rate, which has stood at 1.5% since 2015.

The inflation argument has the support of the International Monetary Fund as well. But then there’s the baht.

The Thai baht has been the best performing currency in Asia. Until October 12, the unit was up 7.5% against the US dollar in this year.

The strength of the baht is detrimental to Thailand’s exports, and low exports drag on economic output. Coupled with slow inflation and relatively low growth, a strong domestic currency also presents a case for a rate cut.

However, on its part, the Bank of Thailand has stuck to its position of maintaining its key rate at 1.5% as it holds that a rate cut at this juncture could increase risks to financial stability. Cheaper credit would raise already high levels of indebtedness.

As far as economic expansion is concerned, the central bank holds that growth is above trend. It recently upgraded its view on the rise in economic output to 3.8% for both this year and the next from 3.5% and 3.7% in its July forecast.

Meanwhile, the central bank has been intervening in the forex market to control the rise of the baht as it feels that a rate cut will not have the desired effect of weakening the currency being that investors are confident in the economy. The weaker dollar has swelled the country’s forex reserves to over $200 billion.

Rate cut, inflation and bonds

Inflation is one indicator that continues to remain low even though Thailand’s central bank expects economic growth to pick up. And subdued consumption and weak wages are expected to continue putting downward pressure on price growth.

Bank of Thailand now expects inflation to be 0.6% in 2017 and 1.2% in 2018, down from 0.8% and 1.6% respectively according to its July forecast.

Consumption spending is expected to rise after the mourning period over the passing of HM the late King Bhumibol Adulyadej ends on October 27. This can help resuscitate inflation, apart from supporting economic output.

The chances of a rate cut in Thailand are not exceptionally high. However, if inflation continues to disappoint and the baht remains strong, thus impacting economic output, the central bank may need to move to ease monetary policy.

Though Thailand’s yield curve is upward sloping, yields across most maturities have declined this year.

Low inflation expectations have already led to a 50 basis point decline in yields on Thailand’s 10-year bond this year. From its peak towards the end of 2016, the yield on the bond is down 70 basis points.

In the medium-term, a rate cut can help raise inflation expectations and thus increase yields on longer-term bonds. This can steepen the yield curve, thus opening up opportunities for investment.

Though the Bank of Thailand is not going to base its policy stance on movement in bond yields, it can be a good indicator of what the market feels, especially about inflation. And at this point in time, the market view is not positive on inflation growth.

This is post 1 of 2 in the series “Unexpected Monetary Policy Action in These Countries Can Influence Bond Yields”

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